Net capital flows may fall short of target

Written by KG Narendranath | New Delhi | Updated: Sep 30 2011, 05:47am hrs
With the Euro zones sovereign debt crisis unlikely to resolve without an implosion, India could miss its official net capital flows estimate for this fiscal by a wide margin. The countrys capital account surplus for 2011-12 could be nearly $20 billion less than the Prime Ministers Economic Advisory Council's (PMEAC's) estimate of $72 billion, independent analysts say.

The PMEAC estimates are going awry mainly because portfolio equity flows remain evened out even at this half-way stage FII investment in equity stood at a measly $0.48 billion at end-August, a far cry from $14 billion forecast by the council for the whole fiscal, itself less than half of the inflows last year. The situation might not be as bad in the case of FDI inflows, but there are concerns on that front also. These two non-debt creating inflows FDI and portfolio equity have, in recent years, been the principal sources for financing the countrys current account deficit (CAD).

Indicating that the capital flow estimate might have to be revised, PMEAC chairman C Rangarajan said on Thursday: I see, at this moment, a problem in financing the current account deficit of that order (2.5% GDP), especially when financed by capital inflows.

Even debt flows, so far relatively strong, could see a drying up in the second half of the year. While trade credits are up, external commercial borrowings, which stood at a healthy $12 billion in April-July, might slow down because of the reduced risk appetite of western lenders and the rupees weakening against the dollar. Notwithstanding the relaxation of ECB rules by RBI and the new facility for yuan-denominated debt, the deceleration of the rupee could impact the demand for overseas loans from corporate India in the second half of the fiscal, said Mathew Joseph, professor at FORE School of Management, Delhi.

Although there is a substantial interest rate differential between Indian and foreign debt 2 percentage points for a fully hedged three-year loan it remains to be seen whether this would counterbalance the push for a decline in ECB sourcing.

The countrys capital account surplus reached a record $108 billion in 2007-08, the third consecutive year when the economy expanded at over 9%, but the surplus dipped to $8.7 billion in 2008-09, the year which saw the worst effects of the recession in Western economies.

A reduction in capital flows could lead to a further decline of the rupee which could inflate the import bill and consequently the CAD. India's merchandise trade deficit stood at $43 billion in April-July, despite a heady growth in exports. A weak rupee can also fuel imported inflation. Not only the imports of oil and metals but also that of edible oils would become costlier. A solace could be the likely continued robustness of remittances, looking for higher returns. But if the Western world plunges into another recession, remittances also will be adversely impacted.

The sharp decline in net capital flows this year would leave the RBI with nothing to add to its foreign currency assets, after financing the CAD. A worse situation could be even a difficulty in fully financing the CAD which by itself could exacerbate and be slightly higher than the projected $54 billion or 2.7% of the GDP.

Only the estimate of net FDI inflow of $18 billion by the PMEAC looks somewhat closer to reality at this stage total FDI inflows in April-July were about $15 billion, as against the estimate for inbound FDI of $35 billion for the whole fiscal. Large cross-border deals like the $7-billion Reliance-BP deal could bolster FDI figures. The strong underlying private consumption demand in the economy could continue to lure foreign investors in a global situation where it is truly a rarity.

There are analysts who are even hopeful of a surge in FII inflows into Indian equities in the coming months. Portfolio equity flows for the whole year could be as high as $10 billion unless the European crisis aggravates, said Abheek Barua, chief economist, HDFC. Sounding optimistic about capital inflows, he said: Given that the cycle of interest rate hikes is soon to come around and inflation has peaked, Western lenders could look more favouarbly at Indian companies in the second half of the year. After all, it may not be right to extrapolate the current trend to arrive at numbers for the whole year. Joseph, however, sees a worsening of the balance of payments situation in the coming months.

What India can hope for is that Europe would avert a sovereign debt default and a consequent recession. Thankfully, the German lawmaker on Thursday decided to reinforce the Euro zones' bailout fund European Financial Stability Facility by guaranteeing loans of up to 211 billion euros.